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Big Pension Payments Loom

Shift to fixed-income assets could buoy bond prices.

Many companies will make big contributions to their pension plans again this year, raising such issues as what asset allocation companies should use and how to time their contributions. Given the trend toward increasing pension plans’ allocations to fixed-income securities, consultants point out that the demand from pensions could affect the pricing of investment-grade corporate bonds.

As interest rates inched up and stock markets rallied this year, the funded status of defined-benefit pension plans has improved. Benefits consultancy Mercer put the aggregate funded ratio of S&P 1500 companies at 82% as of March 31, up from 75% at the end of 2011.

Still, S&P 1500 companies plan to contribute about $54 billion to their pension plans in 2012, based on the data in their 10-K filings, Mercer says. In 2011, those companies put about $70 billion into their plans, more than the $50 billion in contributions they said they would make in their 10-K filings.

Jonathan Barry, a partner and head of Mercer’s retirement risk and finance business in New England, says the decline in interest rates in 2011 meant plan sponsors watched their funded status decline during the year, raising the prospect of higher contributions this year and even the benefit restrictions imposed on plans whose funded status is below 80%.

“We think sponsors seeing the bad year as it was developing wanted to get ahead of some of those things,” Barry says, adding that if pension plans’ funded status declines again this year, plan sponsors could once again contribute more than they originally planned.

Mercer’s data suggest plan sponsors are slowly shifting more of their assets into fixed-income securities, with the average allocation rising to 40% at the end of 2011 from 37% in 2010. Companies that are altering their asset allocation can take advantage of a big contribution to get started on that change, Barry says. “That avoids some of the transaction costs in selling equities. It’s a little bit simpler way to go about it.”

Bob Collie, chief research strategist for Americas institutional at Russell Investments, says when companies make a sizable payment to the plan, they might also want to shift toward a bigger allocation to fixed income in order to take less risk.

“That’s not worth doing unless it’s a pretty big contribution,” says Collie, pictured at right. “That’s what’s different—it’s going to be more common that the contribution is big enough itself.”

The shift toward fixed income could show up in the pricing of corporate bonds, though. “There’s not enough long credits around if every plan sponsor wanted to move their plans into long credit,” Barry says. “Interest rates could stay fairly low for corporate bonds over the next several years as there’s more and more appetite for pension plans to be buying these bonds.”

Collie also expects pension contributions to have an impact. “If you look specifically at corporate bonds, especially the long end of the market, you have a relatively small market and not that heavily traded,” he says. “If a significant part of these contributions goes into long corporate bonds, which we expect to happen, the relative size of contributions to daily volume creates the possibility of market impact for sure.”

Collie notes that many pension contributions from calendar-year plans occur in September and warns that plan sponsors investing their contributions this year could face a “September rush.” It suggests that companies with cash on hand consider making their contributions earlier in the year.

One remaining uncertainty facing plan sponsors is whether Congress will provide additional funding relief. The Senate included a measure in a transportation funding bill it passed last month that would significantly reduce pension contributions. But the House enacted a 90-day extension for transportation funding in late March, which means nothing will happen at least until this summer.

“That extra 90 days I think significantly reduces the probability of anything happening in time,” Collie says. “At the moment, it does seem to us that odds for significant relief coming through in 2012 seem to be diminishing.”

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